Your current browser is not capable of using this site without JavaScript. Please use an updated browser or enable JavaScript to continue.

Technical 21 Jan 2014 05:03pm

Pensions: lifetime allowance charge

A breakdown of the reduction in lifetime allowance which comes into force from the 2014/15 tax year

In brief

• The lifetime allowance will be reduced from £1.5m to £1.25m with effect from 6 April 2014

• Individuals may apply for FP14 provided that they cease DC contributions and DB accrual above a specified percentage

• Individuals may also apply for IP14, under which it will be possible to continue to build up pensions savings.

Next steps

• Individuals affected by the reduction should take independent financial advice on their options

• Individuals who plan to apply for FP14 need to do so before 6 April 2014

• Individuals who plan to opt out before 6 April 2014 need to give early notice to their pension scheme(s)

• Trustees should decide how to deal with any members who wish to rely on IP14 but retire before the form is available.

The Chancellor of the Exchequer announced in his 2012 autumn statement that the lifetime allowance would be reduced from £1.5m to £1.25m with effect from the 2014/15 tax year.

HM Revenue and Customs (HMRC) have subsequently confirmed that there will be two new types of protection available for individuals affected by the reduction: fixed protection 2014 (FP14) and individual protection 2014 (IP14).

Background

The 2014/15 reduction will be the second reduction to the lifetime allowance in recent years: it was previously reduced from £1.8m to £1.5m with effect from 6 April 2012. At the time of this first reduction, a new type of transitional protection was introduced, called ‘fixed protection 2012’ (FP12). There are also two further transitional protections from the lifetime allowance charge dating back to 6 April 2006, namely enhanced protection (EP) and primary protection (PP).

Following the 2012 autumn statement, legislation implementing FP14 was made via the Finance Act 2013. HMRC also consulted in June 2013 on whether there should be an alternative type of protection, IP14. On 10 December 2013, it published a formal response to that consultation confirming that it would introduce IP14. It also published draft clauses for the Finance Bill 2014 implementing IP14 as well as draft guidance providing more detail on how IP14 will work in practice.

Although both FP14 and IP14 will apply with effect from 6 April 2014, the legislation implementing IP14 will not come into force until the Finance Bill 2014 receives Royal Assent (expected to be in July 2014). This means that it will not be possible for individuals to apply for IP14 until around mid-August 2014. However, any applications for FP14 must be made before 6 April 2014.

Fixed protection 2014

Under FP14, an individual will be given a lifetime allowance equal to the greater of £1.5m and the standard lifetime allowance, provided that they do not make contributions to a defined contribution (DC) arrangement or accrue benefits in a defined benefit (DB) arrangement in excess of a relevant percentage on or after 6 April 2014. The relevant percentage is defined as:

Where there is a rate specified in the rules on 11 December 2012, that rate (in addition to any statutory increase); or

Otherwise, the greater of the increase in September-to-September CPI and statutory increases.

Briefing Note

Individuals wishing to apply for FP14 will therefore need to cease any contributions to a DC arrangement before 6 April 2014 and are also likely to need to opt out of any DB arrangements. Individuals can only apply for FP14 if they do not already have PP, EP or FP12. It will be possible to apply for both FP14 and IP14. Individuals must notify HMRC that they intend to rely on FP14 before 6 April 2014 using a form on the HMRC website. If they later lose FP14, they must notify HMRC within 90 days from the date when they could reasonably be expected to have known it was lost.

Individual protection 2014

A key difference between IP14 and FP14 is that individuals will be able to continue to make DC contributions or have further DB accrual on or after 6 April 2014, with any excess over their personalised lifetime allowance being subject to the lifetime allowance charge. This means that IP14 may be particularly attractive in cases where individuals would not be able to receive higher pay in lieu of pension if they opted out of the scheme (and therefore it is likely to be more valuable for them to remain in the scheme even if some of their savings will be taxed).

Key features of IP14

The draft Finance Bill clauses provide the following details:

• Individuals will be able to apply for IP14 if they have pension savings greater than £1.25m as at 5 April 2014

• Under IP14 individuals will have a personalised lifetime allowance of the value of their pension savings as at 5 April 2014 (up to a maximum of £1.5m). This will be a fixed amount and not indexed to any possible future increases in the standard lifetime allowance. However, if the standard lifetime allowance at some point increases above the level of the personalised lifetime allowance, individuals with IP14 would revert to the standard lifetime allowance

• As mentioned above, it will be possible to continue to have further DB accrual/DC contributions without losing IP14. Any excess over the personalised lifetime allowance will be subject to the lifetime allowance excess charge (55% on excess benefits taken as a lump sum and 25% on such benefits taken as a pension). This includes any excess arising from DB revaluation (including statutory revaluation) or DC investment growth as well as new DB accrual or DC contributions

• Individuals with IP14 will be entitled to take up to 25% of their pension benefits as tax-free cash (subject to a maximum of 25% of their personalised LTA).

HMRC has confirmed that no adjustments will be made to the level of the personalised lifetime allowance when an individual’s benefits have been reduced for ‘scheme pays’ (where an annual allowance charge is met via a reduction to benefits).

Interaction with other forms of protection

Individuals with any of EP, FP12 or FP14 will also be able to apply for IP14. EP, FP12 or FP14 will take precedence but, if that protection is lost, the member will be able to fall back on IP14. However, individuals with PP will not be able to apply for IP14. In the original consultation, HMRC had considered not allowing individuals with EP to apply for IP14, so this is welcome news for individuals with EP (but not PP) who can now use IP14 as a limited safety net in the event that EP is lost.

If the IP14 is ‘dormant’ because the member has one of EP, FP12 and FP14, HMRC will confirm to the member that they have IP14, but will not issue a certificate unless the other protection is lost.

Applying for IP14

In a similar manner to previous protection regimes, there will be a three year window for applying for IP14 until 5 April 2017, which is intended to give sufficient time for individuals to obtain valuations of their various pension benefits. Benefits will need to be valued as at 5 April 2014 in line with the current legislation, although valuations with a date from 31 March 2014 to 4 April 2014 will be acceptable so long as there has been no material change in the assets since that date. Applications must be made on a form which will be made available on the HMRC website.

As noted above, the form for applying for IP14 will not be made available until mid-August 2014. This will cause a particular problem for individuals planning to retire between 6 April 2014 and the date that their IP14 is confirmed. In its draft guidance, HMRC suggests four options for scheme administrators faced with this situation:

• Ask the member to defer retirement until IP14 is confirmed

• Ask the member to limit the benefits they put into payment to the standard lifetime allowance and defer their remaining benefits until IP14 is confirmed

• Operate as if the member did not have IP14 and deduct tax accordingly (noting that it is possible that IP14 may be confirmed and the available lifetime allowance recalculated before the tax actually needs to be paid to HMRC)

• Operate as if the member had IP14. However, HMRC indicates that they would be unlikely to exempt schemes from the scheme sanction charge in the event that it subsequently turned out that the member did not qualify for IP14. This is likely to make this an unattractive option.